Microsoft, Alphabet, Amazon are ‘the leaders in a paradigm shift’ toward AI, strategist says

Baird Technology Strategist Ted Mortonson joins Yahoo Finance Live to discuss quarterly earnings for Microsoft and Alphabet, cloud growth, the expectations for Amazon’s quarterly earnings, and the outlook for generative AI.

Video Transcript

BRAD SMITH: Well, sticking with the two that have already reported. Microsoft and Alphabet reported strong cloud computing revenue, proving businesses are still spending big, but growth has slowed compared to peak rates in 2021. So what does the future look like for cloud tech? And joining us now, we've got Ted Mortonson, who is the Baird Technology strategist. And Ted, great to have you here with us this morning, first and foremost.

When I looked at these numbers, and especially zeroed in on Alphabet's numbers particularly, it was noteworthy the growth that they saw in their cloud division, as well as the profitability, even at a time where we were talking about coming into this earnings season it being in an environment of more deals scrutiny. Interested in what you make of that and what this really kind of sets forth in terms of the growth narrative that these companies have really been pitching to the Street and to customers?

TED MORTONSON: Well, I think what you're seeing is you're seeing a rationalization of really cloud spend by the global 2,000. I mean, we had a huge peak due to application loads during COVID. That has moderated. And you can see it both in the Microsoft and Google numbers.

If you look at Microsoft-- your previous guest summed it up well-- the previous quarter, they grew 38%, they guided to 31%, and they hit that number. And that was better than feared by the Street. They guided forward Azure growth at 26% to 27%. So you're seeing that moderation. This is all before you integrate generative AI so that's a positive.

As it relates to Google, I would somewhat challenge the thought process that Google is behind. They pioneered AI with DeepMind. And they just rolled out Bard. They're holding a lot of cards here. And I think to some degree, the Street may be leaning one way. These are two brilliant companies with unbelievable managements.

And generative AI is gonna affect every single industry for, you know, the next decade. It's probably one of the largest technology evolutions I've seen in my 30-year career of doing technology. And as an engineer, it is a feat, not only on the silicon side but on the software side.

I think what happens tomorrow with Amazon is incredibly important for the tape. Last quarter, they grew 20%. The Street has a very negative bias on their channel checks on Amazon in relationship to AWS growth. And I think this is gonna be a very important report tomorrow.

Also, the Street is very, very focused, not only on AWS growth rate, but for Amazon this is a major contributor to operating margin. AWS contributed almost $5.2 billion of profitability last quarter with operating margins of 24.3%. That engine's got to keep going to fuel the investment that Amazon is doing on their core ecommerce.

JULIE HYMAN: So Ted, let's talk about then the three big cloud players, given what you're saying about AWS. Because my read through from Microsoft and Alphabet was that companies are still spending on cloud, right? Not going up at the same rate, obviously. But that spending is not being eroded as much as we might have anticipated, given that it's the, quote-unquote, "year of efficiency" for many companies.

Are we not going to see that same effect in AWS? Does AWS not have the same kind of bolt on services for cloud that the other players do? Or could they potentially surprise to the upside, also?

TED MORTONSON: They could. And again, sentiment is pretty negative here on the AWS print. I think with AWS, you also have to realize in their infancy of cloud, the private companies were a very big contributor for AWS. When you were in the Silicon Valley and doing a start up, your cloud infrastructure bill was directly to Amazon.

And I think post-Silicon Valley's failure, that smaller component now on the private side is definitely seeing some pressure. Now, with that said, you look at these three clouds-- AWS, Azure, and GCP-- they are true monopolies. They're worldwide monopolies. Outside of China, Baidu, and Alibaba, they're holding 90-plus-percent of the AI engineers. And as you move into generative AI, these three companies are going to be the leaders in a paradigm shift-- not only in search but across all industries as software changes.

And Microsoft is incredibly well-positioned because of their enterprise reach. And I think Dan summed it up very, very well where you're-- when you look at Microsoft, they're already commercializing AI with what's called Copilot. And Copilot's being commercialized on the developer with GitHub. It's being commercialized on security with their E5 offering. It's through dynamics.

Microsoft is actually rolling it out to the enterprise right now and I think that's their core advantage, at least in the near term.

BRAD SMITH: You know, the way of thinking among some of their portfolio clients in the past would be, all right, if we've already got our collaborative cloud suite with this company, then we might as well kind of have a data center that's housed by this company, as well. Kind of just summarizing everything up in one bill, if you will.

Is that still the way of thinking? Are companies looking to piecemeal together a broader kind of cloud solution for themselves? Or are they kind of picking and choosing? And if so, is there a clear winner right now among some of the largest cloud players that you're tracking?

TED MORTONSON: That's the million dollar question and it's a great question. I think if you look at AWS being kind of the number one cloud player, historically, and Azure being number two, and GCP being number three, and Oracle's OCI being a distant four, right now this is a battle between Microsoft and Google. Microsoft, again, has the enterprise, which is a huge advantage. You know, all corporate enterprises, essentially their foundation is Microsoft.

And as you look at the roadmap, it is a scary roadmap. It's almost kind of like the technology Deskstar, if you will. Microsoft is an incredibly brilliant management that executes. And in that respect, I think as you move into generative AI-- they've been working with OpenAI for years in a huge investment. OpenAI is powered by NVIDIA, it sits on Azure.

That's a pretty big initial advantage in this next war. And it is a generational paradigm. So I would say, Microsoft is holding a lot of cards right now.

JULIE HYMAN: Just super quickly, Ted, does the lack of Activision affect that Deathstar ability?

TED MORTONSON: No. It's a bolt-on that-- it's a bolt-on, quite frankly, that would have been nice to move their whole gaming business to the cloud. But the core IP within Microsoft is feeling multiple product cycles currently.

JULIE HYMAN: So I guess I don't know what the vulnerability was, that you shoot the photons down into the middle and the whole thing blows up. I don't know what they-- well, the analogy only goes so far. Ted Mortonson, thank you so much. We love that analogy, though. A Baird Technology strategist, and great to get some time with you this morning. Thanks.